Question

Decision on transfer pricing Materials used by the Instrument Division of XPort Industries are currently purchased from outside suppliers at a cost of $194 per unit. However, the same materials are available from the Components Division. The Components Division has unused capacity and can produce the materials needed by the Instrument Division at a variable cost of $161 per unit. Assume that a transfer price of $184 has been established and that 45,900 units of materials are transferred, with no reduction in the Components Division’s current sales. a. How much would XPort Industries’ total income from operations increase? $ b. How much would the Instrument Division’s income from operations increase? $ c. How much would the Components Division’s income from operations increase? $ d. Any transfer price will cause the total income of the company to increase , as long as the supplier division capacity is used toward making materials for products that are ultimately sold to the outside. Feedback a-c. Multiply the units transferred by the difference between the transfer price and the variable cost per unit (supplying company) or the market price and the transfer price (purchasing company). d. Consider the effect of setting a transfer price outside the acceptable range. Learning Objective 5.

Answer 1

Solution a:

Increase in total income from operations for XPort Industries = Unit transferred * (Market price - Variable cost per unit) = ($194 - $161) * 45900 = $1,514,700

Solution b:

Increase in income from operations for Instrument division = Unit transferred * (Market price - Transfer price) = 45900 ( $194 - $184) = $459,000

Solution c:

Increase in income from operations for Component division = Unit transferred * (Transfer price - Variable cost) = 45900 ( $184 - $161) = $1,055,700

Solution d:

Let transfer price is set for $200.

Then increase in income of instrument division = 45900 * (194 -200) = ($275,400)

Increase in income of component division = 45900 * (200 - 161) = $1,790,100

Overall increase in income of company = $1,790,100 - $275,400 = $1,514,700

Therefore, Any transfer price will cause the total income of the company to increase , as long as the supplier division capacity is used toward making materials for products that are ultimately sold to the outside